Readers' comments

Michael Pettis's article on China is interesting (and a little alarming). It would seem that China may enter a genuine recession (contracting GDP) in the next two or three years. Given the volume of bad debts, a couple of years of low growth may force mass write-downs, stalled investment (a fall from 50% of GDP to perhaps 40% would directly remove 10% of GDP, unless resources can be shifted to other sectors), bankruptcies (the businesses that worked on investment projects), tax increases (to make up for lost real estate revenue), rising capital costs for exporters (as financial repression winds down), etc.

Holy cow - China's going to become a less stable place for us to produce. It might be starting already - can air be let out of the bubble without (and before) a collapse?

Exporters dependent on capital equipment sales to China will have to find new markets. Resource exporting countries might be ready for substantial falls in energy and resource prices as capacity runs ahead of demand - will there be fiscal problems, and revolutions?

While Chinese rebalancing is essential in the long run - both for Chinese living standards and for sustainable global growth - it isn't clear whether the short run impacts will be beneficial or damaging in the US/ EU.

For sure, lower energy and resource prices are always a boost (oil alone, at just over $400 billion, makes up around 20% of all EU imports). This would have the greatest impact where it matters most: in Greece, Italy, Spain and Portugal. On the other hand, capital and luxury goods exports from Germany and the Netherlands would probably suffer painfully. On both counts, a Chinese rebalancing would contribute to ongoing rebalancing within the eurozone.

Lower natural resource prices would mean that sovereign wealth funds - Russia and the Middle East - sell off their reserves to deal with fiscal problems. In practice, that means less demand for US treasuries. Unless this is corrected for by outflows of capital from China (which would seem unlikely), that suggests that treasury yields will tend to increase in response to rebalancing. While lower resource costs and repatriation of production would probably cause enough growth to close some of the US federal deficit, rising yields would have the opposite impact - all the more so if the deficit hasn't fallen to normal levels by this time.

Keynes, particularly when and after he wrote ‘The General Theory of Employment, Interest and Money’ (1936), used to emphasise various fixed factors of production or irreversibility of real investment in the real world and thus did not trust the conventional argument that a wholesale liberalisation of economy would eventually realign the state of the aggregate investment into a favourable state towards full employment (i.e. Say’s law No. 1).

At the same time, he also abandoned his old idea, idea up to A Tract on Monetary Reform (1923) and A Treatise on Money (1930), that a wholesale control of the aggregate demand could eventually realign the breakdown of the real investment into a favourable state towards full employment (i.e. Say’s law No. 2).

In the GT, he summarises what I call ‘favourable state’ as improvement in the schedule of the marginal efficiency of capital. Just because you were able to increase the volume of the aggregate investment doesn’t mean the schedule of the marginal efficiency of capital has improved.